Hustle from Brussels: the UK’s race to bid Solvency II adieu

The UK insur­ance indus­try is poised for a shake-up that’s like­ly to release tens of bil­lions in invest­ment for gov­ern­ment projects aimed at build­ing green­er infra­struc­ture and advanc­ing Boris Johnson’s “lev­el­ling up” pol­i­cy.

West­min­ster wants to clear away numer­ous reg­u­la­to­ry obsta­cles – a lega­cy of EU mem­ber­ship – that have hith­er­to dis­suad­ed pen­sion funds and insur­ers from chan­nelling as much mon­ey into net-zero mod­erni­sa­tion pro­grammes as it would like. Its planned changes would allow more invest­ment cap­i­tal to shift from bonds to wind farms, for exam­ple. Crit­ics of the cur­rent rules argue that they make it eas­i­er for insur­ers to invest in coal min­ing than in renew­able ener­gy.

Keen to demon­strate a ben­e­fit of Brex­it, the gov­ern­ment has called for an “invest­ment big bang” and is tar­get­ing the insur­ance industry’s con­sid­er­able cof­fers. Hav­ing dis­cussed the mat­ter for the past year, min­is­ters are thought to be close to agree­ing reforms with the sector’s reg­u­la­tors, with a focus on main­tain­ing safe­guards for insur­ers and pol­i­cy-hold­ers.

But this over­haul lags a sim­i­lar ini­tia­tive already afoot in Brus­sels to unlock €90bn (£76bn) in EU insur­ance assets. The Euro­pean Com­mis­sion has adopt­ed a com­pre­hen­sive review of its insur­ance rules, known as Sol­ven­cy II, so that insur­ers in the bloc can scale up long-term invest­ments in Europe’s recov­ery from the Covid cri­sis and the impacts of Russia’s war against Ukraine. 

EU insur­ers will be incen­tivised to increase long-term cap­i­tal invest­ment to boost mem­ber states’ economies, but at the same time the indus­try will be bet­ter scru­ti­nised, accord­ing to the com­mis­sion.

West­min­ster is keen to push ahead with its plans, because the UK would be put at a com­pet­i­tive dis­ad­van­tage if Brus­sels were to enact its pro­posed reforms first.

In Feb­ru­ary, the eco­nom­ic sec­re­tary to the Trea­sury, John Glen, revealed the government’s plan to shake off some of the shack­les of Sol­ven­cy II, which the UK had adopt­ed when it was an EU mem­ber state. He out­lined the pro­posed changes in a speech at the annu­al din­ner of the Asso­ci­a­tion of British Insur­ers (ABI). 

Glen said that the over­haul would cre­ate a more bespoke and dynam­ic regime, unlock­ing bil­lions for infra­struc­ture invest­ment. But he stressed that safe­guard­ing the finan­cial sta­bil­i­ty of insur­ers and pro­tect­ing pol­i­cy-hold­ers would remain a top pri­or­i­ty.

British insur­ers have been sub­ject to Sol­ven­cy II since it was intro­duced in 2016 to har­monise reg­u­la­tion across the EU. Glen pledged that this “EU-focused, rules-dri­ven, inflex­i­ble and bur­den­some” body of reg­u­la­tion would be slimmed down and adjust­ed to bet­ter suit the nation’s pub­lic invest­ment needs. 

“EU reg­u­la­tion doesn’t work for us any­more. The gov­ern­ment is deter­mined to fix that by tai­lor­ing the pru­den­tial reg­u­la­tion of insur­ers to our unique cir­cum­stances,” he said. “We have a gen­uine oppor­tu­ni­ty to main­tain and grow an inno­v­a­tive and vibrant insur­ance sec­tor, while pro­tect­ing pol­i­cy-hold­ers and mak­ing it eas­i­er for insur­ance firms to use long-term cap­i­tal to unlock growth.”

The reform pack­age has been devel­oped by the Trea­sury along­side the Bank of England’s Pru­den­tial Reg­u­la­tion Author­i­ty (PRA), which has empha­sised the need for main­tain­ing effec­tive mea­sures to ensure that firms and their pol­i­cy-hold­ers aren’t exposed to any more risk as a result of the changes.

In Decem­ber 2021, the Bank’s gov­er­nor, Andrew Bai­ley, stressed that the PRA’s prime focus would be to safe­guard their inter­ests. Address­ing the Insti­tute and Fac­ul­ty of Actu­ar­ies at the time, he added: “Reform­ing Sol­ven­cy II is sen­si­ble, because the world moves on – and because it was nev­er well suit­ed to some aspects of the UK mar­ket.”

Planned reforms include a sub­stan­tial reduc­tion in the risk mar­gin, includ­ing a cut of between 60% and 70% for long-term life insur­ers and the more sen­si­tive treat­ment of cred­it risk in the so-called match­ing adjust­ment. The risk mar­gin cal­cu­lates the reserves that life insur­ance firms must hold and the match­ing adjust­ment pro­tects against price volatil­i­ty, incen­tivis­ing investors to back secure long-term assets.

The risk mar­gin and the match­ing adjust­ment are two key areas of scruti­ny, accord­ing to Bai­ley. 

“Pub­lic pol­i­cy objec­tives like safe­ty and sound­ness and pol­i­cy-hold­er pro­tec­tion are the bedrock of pru­den­tial insur­ance reg­u­la­tion,” he said in his speech. “But let’s not assume that the answers to the ques­tion of how much of it we should have are obvi­ous. That said, I can­not empha­sise enough that we must come up with well-con­sid­ered answers to the ques­tion of ‘how much pro­tec­tion?’ to allow pru­den­tial reg­u­la­tion to do its job effec­tive­ly.”

As well as giv­ing insur­ers more flex­i­bil­i­ty to invest in long-term assets, the reform pack­age includes reduc­tions in their admin­is­tra­tive bur­den and report­ing oblig­a­tions.

Char­lotte Clark, direc­tor of reg­u­la­tion at the ABI, believes that reforms to Sol­ven­cy II are “vital to ensure that we have a post-Brex­it reg­u­la­to­ry regime that’s fit for pur­pose for the UK and not over­ly restric­tive. It should enable more invest­ment in green infra­struc­ture and the lev­el­ling-up agen­da. Analy­sis shows that £95bn could be freed up if sen­si­ble changes are made to the match­ing adjust­ment and the risk mar­gin, while uphold­ing high lev­els of pro­tec­tion for pol­i­cy-hold­ers.”

The gov­ern­ment is due to pub­lish a full con­sul­ta­tion doc­u­ment in April. This should fea­ture more detailed pro­pos­als with sup­port­ing analy­sis.

The Pen­sion Insur­ance Cor­po­ra­tion (PIC), which holds more than £47bn in invest­ments, agrees that the Sol­ven­cy II frame­work for insur­ance com­pa­nies has ham­pered the UK’s invest­ment in low-car­bon projects so far.

In Decem­ber 2021, the PIC pub­lished a research report enti­tled Invest­ment Unleashed, which argued that flaws in the reg­u­la­tion had incen­tivised life insur­ance firms to invest pri­mar­i­ly in large, well-fund­ed com­pa­nies. This had skewed invest­ments towards mature tech­nolo­gies and sec­tors, rather than help­ing the gov­ern­ment to achieve its goals in respect of build­ing green­er infra­struc­ture and lev­el­ling up the econ­o­my.

“The government’s lev­el­ling-up and net-zero ambi­tions require sig­nif­i­cant invest­ment if they are to be achieved. Quite sim­ply, the gov­ern­ment itself can­not pro­vide this fund­ing,” the report states.

The PIC’s chief exec­u­tive, Tra­cy Black­well, views the planned Sol­ven­cy II reforms as a chance to rewrite the script. “We have a once-in-a-life­time oppor­tu­ni­ty to chan­nel new invest­ment into com­mu­ni­ties across the UK, build­ing high-qual­i­ty homes, decar­bon­is­ing our econ­o­my, cre­at­ing jobs and lev­el­ling up,” she says.

Clark agrees, not­ing that the ABI has “long been call­ing for the mean­ing­ful reform of Sol­ven­cy II. The changes being dis­cussed will not dimin­ish the high reg­u­la­to­ry stan­dards that are right­ly placed on insur­ers and long-term sav­ings providers. These will retain their abil­i­ty to with­stand a one-in-200-year shock.”

She con­tin­ues: “Our sec­tor recog­nis­es the cru­cial role it has to play in tack­ling cli­mate change. Call­ing for reg­u­la­to­ry reforms to enable more invest­ment in renew­able ener­gy, as well as oth­er infra­struc­ture need­ed to aid the UK’s tran­si­tion to net zero, is just one aspect of the many actions we are tak­ing.”